Mortgage equity loan against redemption with redemption: advantages and disadvantages

Many Americans suddenly become wealthy at home. On paper, however.

Rising house prices have resulted in a record home equity. By the end of last year, some 46 million homeowners had a total of $ 7.3 trillion in equity, the largest amount ever recorded, according to Black Knight, a mortgage technology and research firm – the equivalent of about $ 158,000, on average, per homeowner.

This, along with near-low mortgage rates, has led to a growing number of borrowers making money out of their homes.

In the first quarter of 2021, the amount of equity redeemed rose to $ 49.6 billion – the highest level since 2007, when housing last boomed. Including home equity credit lines, Americans have raised a total of $ 70.4 billion in recent months alone, according to the latest figures from Freddie Mac.

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Although the volume of redemptions is the highest in almost 15 years, given how much equity homeowners have, “the amount being redeemed is quite modest,” said Len Kiefer, Freddie Mac’s deputy chief economist.

However, accessing this money is not always easy. Since the onset of the Covid pandemic, the entire industry has increased access to mortgages, and several large banks have stopped offering home equity credit lines and refinancing refinancing to reduce their exposure – or risk – to uncertain economic times.

How is a HELOC and a redemption refinance different?

Until last year, a HELOC, which is a revolving credit line but with better interest rates than a credit card, was a popular way to lend to the equity you have accumulated in your home.

The average interest rate on this type of loan is 4.86%, according to Bankrate.com. Credit cards, meanwhile, charge almost 16%, on average.

Some banks still offer this option, although most have tightened their standards, at least somewhat. This means that homeowners need to have higher credit scores and lower debt-to-income ratios.

“In general, the higher your credit score, the easier it will be to access equity,” said Tendayi Kapfidze, chief economist at LendingTree.

There is, however, a better way to free up some of that money, he added.

“Because interest rates are so low, your best bet will be refinancing by redemption,” Kapfidze said. “Interest rates are lower than a mortgage rate and lower than the current mortgage rate.”

Homeowners may also be able to deduct interest on the first $ 750,000 of the new mortgage if the redemption funds are used for capital improvements (although because fewer people now report in detail, most households will not benefit from this write-off).

This works well when mortgage rates fall, because even though you are refinancing your current mortgage and taking out a bigger mortgage, you are reducing your interest payments at the same time.

“Significant opportunities continue to exist today, as nearly $ 2 trillion in compliant mortgages have the potential to refinance and cut interest rates by at least half a percentage point,” Sam Khater, chief economist at Freddie Mac, said in a recent statement.

“If you weren’t looking at interest rates last year, now would be a good time to check it out,” said Douglas Boneparth, a certified financial planner and president of Bone Fide Wealth in New York.

On a 30-year mortgage, interest rates below 3% are still widely available. “Even those who received fairly low interest rates are refinancing at lower interest rates today,” said Boneparth.

However, the most preferred terms go to borrowers with high credit scores. “Most people have pretty good credit, but the best interest rates go to those with 740 or higher,” added Greg McBride, chief financial analyst at Bankrate.com.

It’s not 2005, you can not extract the last nickel you have at home.

Greg McBride

Chief Financial Analyst at Bankrate.com

Sure, there are some restrictions on redemption refinancing, too.

For starters this is a great way to get word out that most lenders will need to keep at least 20% of your home equity, if not more, in the event of a fall in house prices.

“It’s not 2005, you can not get the last nickel you have at home,” McBride added.

In addition, redemption refinancing often means extending your repayment period, which can squeeze out your monthly budget in the long run, and you may have to pay the closing cost in advance.

As a rule of thumb, “if you can cut your percentage by half to three-quarters of a percentage point, it’s worth a look,” McBride said. “This is usually the turning point.”

Then, “you can get your costs back in a year and a half,” he said, and “refinancing becomes very compelling.”

Finally, refinancing opportunities could be short-lived. Mortgage rates will not stay low forever, especially as inflation rises.

“This should add some urgency to refinancing sooner rather than later,” McBride said. “The economy is heating up – these are the conditions that produce higher mortgage rates.”

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